‘Fundamental flaws’: What networks operators said about RIIO-2

Ofgem has published much of the evidence submitted to its RIIO-2 consultation, with network operators largely rallying against a proposed cost of equity range that was beset by “fundamental flaws”.

Last week the industry regulator published an update to its formation of its next set of network price controls, deferring its decision on an appropriate level of return until December pending further work.

But consultation responses submitted by network operators such as Western Power Distribution (WPD), Electricity North West (ENW) and UK Power Networks (UKPN), has made the industry’s assessment of the proposals abundantly clear.

In March the Ofgem said it would be overhauling RIIO in a bid to take a tougher approach on network companies and, ultimately, deliver billions of pounds worth of savings to consumers. Central to these tougher controls was a proposed cost of equity range of between 3 – 5%.

PPL, the parent company of Western Power Distribution’s four main areas, sought to highlight its “significant concerns” over the impact placing the cost of equity at somewhere within Ofgem’s stated range of 3 – 5% would have on its business.

It stated its belief that such a range understated the baseline return needed to attract and retain equity financing.

But one particular topic that was addressed by many of the network companies in response was some of the analysis on the issue conducted by Ofgem’s economics consultant Cambridge Economic Policy Associates (CEPA) and, in particular its attachment of higher premiums to debt risk than equity risk.

Electricity North West said there were “fundamental flaws” in CEPA’s analysis, citing alternative outcomes from another economics consultancy Oxera, however it was UK Power Networks that was most scathing of the proposed range, saying there had been “significant abnormalities” applied by CEPA in setting the industry range and that its application of risk premiums “goes against logic”.

Meanwhile, Northern Powergrid strongly rejected Ofgem’s proposals to index the cost of equity, arguing this has the potential to be highly damaging to network companies’ ability to raise finance an add yet another “unnecessary complication” to the framework.

One area where the DNOs did, however, disagree on was how incentives are to be applied under the new framework. WPD concluded that the use of incentives had “thus far worked well” and should continue, however UKPN was of the opinion that current incentive targets are too easy and should instead be based on revealed benchmarking and updated annually.

Ultimately, WPD concluded that it was important to establish a set of price controls that enables DNOs to attract the necessary capital, whereas UKPN sought to stress that whole system solutions – another area wherein Ofgem has admitted further work is necessary – has yet to be addressed.